Spotify's plan to compete with Pandora by building a similar radio-style online music-streaming platform has one massive flaw: To quote Bloomberg, "The new service would start by year-end and be supported by advertising."

Yikes.

There are only two things you need to know about Pandora's business model:

The finances are simple to understand. Every time Pandora plays a song it must pay a licensing fee to the artist who created the music. Therefore, Pandora must make more money on the ads it shows its users than it pays in song royalty fees. The problem is that each new user plays more and more songs, generating more and more fees. So Pandora must find more and more advertisers to cover that. Of course, advertisers want the largest audience possible. But a larger audience generates larger song fees … you get the point.

It's a vicious cycle in which any ad money Pandora makes is instantly spent on the songs that generated that ad money. In fiscal 2012, pandora lost $16 million on record high revenues of $240 million.

This chart shows that Pandora's operating expenses, which in large part consist of royalty fees, are in lockstep with its revenues, rendering the company permanently unprofitable:

SEC

Those royalty fees, which are negotiated en masse with music industry lobbyists, are set to increase in 2015, threatening Pandora's long-term even further.

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Editors' Picks

Chart assumes that revenue will always have a 1:1 relationship to listening hrs. Assuming as Pandora grows the sales staff CPM's increase the chart has the potential to change. Also they can add advertising inventory, run :60's vs :15's. Ton of opportunities. Right now they need to achieve more scale then really start to monetize in 24-36 months by increasing inventory and/or driving CPM's.